Commodity derivatives markets caught in a downturn

Sebi has liberalised the limits of positions that market players can take

The commodity derivatives markets are caught in a severe downturn. Annual aggregate volumes in commodity derivatives have fallen to their lowest level since 2010 and, at Rs 178.5 trillion (Rs 1 trillion = Rs 1 lakh crore), are a third of the peak seen in 2011-12.

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A fallout of this is that those who have left the market may not come back. A big jobber who had significant shares in volumes a few years ago has shifted base to Singapore. Some have shifted to Singapore, doing jobbing on the Singapore Nifty platform. Many have just left the business or cut staff strength.

The Multi Commodity Exchange (MCX) and the National Commodity and Derivatives Exchange (NCDEX) have lost 30-50 per cent of their active members during the period. This came to light when the Forward Markets Commission (FMC) merged with the Securities and Exchange Board of India (Sebi) and the member-brokers had to register with Sebi afresh. This increased compliance cost.

Edelweiss, a leading player, sold its commodity trading business to Inditrade Business Consultants, a wholly-owned subsidiary of Inditrade Capital, in November last year. Edelweiss had emerged as a large player in trading before that.

Many firms in commodity derivatives broking had started physical trading in agri-commodities but due to uncertain government policies and frequent changes impacting the futures markets, they have abandoned that idea.

Some experts, however, see scope for a turnaround in the shape of new products and players that Sebi has brought in but the leading factors in this will be, as players say, reducing the cost of trading and regulatory/compliance cost.

The imposition of the commodity transaction tax (CTT) on commodity derivatives in July 2013, followed by the National Spot Exchange crisis and crashing commodity prices, have played a role in taking the wind out of the fast-growing commodity derivatives’ sails. However, the consolidation period lasted for almost four years and hopes are high that Sebi, now that it is completing two years of regulating commodity derivatives, will continue opening up the markets.

Sebi has liberalised the limits of positions that market players can take. Some suspended contracts such as those in chana and black pepper futures have been relaunched, and the regulator has permitted the entry of institutional players such as hedge funds, which have made a subdued beginning.

MCX is launching gold options trading, while NCDEX has received permission to launch options in guar seeds. Next month trading in options could start.

Samir Shah, NCDEX managing director and chief executive officer, said: “Options trading will be positive but the markets will take time to adjust since the options design for commodities is different from those of equities. So, we will have to wait and see how the markets react."

After Sebi merged itself with FMC, the erstwhile regulator, it suspended forward trading in many commoditie and tightened position limits.

Exchanges had been exempted from state-imposed stock limits in 2014 but they were withdrawn the next year.

Gaurav Arora, whose Jaypee Capital found place among the highest volume generators by doing jobbing (quick buying and selling), has withdrawn from the market. However, he said that “with options being allowed in commodity derivatives, we recently started trading on the MCX and will soon do so on the NCDEX. Since in options the CTT is applicable on option premiums, there is scope for growth".

Even an executive of a leading hedge/venture fund said that “alternative asset funds are at present looking to take permission from investors to operate in commodity derivatives under the existing equity schemes rather than launching new funds. These pipeline businesses will gradually come".

Allowing mutual funds in commodity derivatives is now on Sebi’s agenda, according to sources. However, “they have experience in equity but not in commodities, which move in cycles. It is likely that they will gain commodity market expertise only to increase their equity business. Many commodity research houses and consultants are now using their commodity expertise in relevant stocks and getting good returns," said an expert in commodity risk management.

What is more required to bring the markets back on track?

In agri-commodities, some government restrictions like stock limits in sugar still continue, and they should go, says an industry executive. Besides, the cost of regulation such as registration and Sebi regulatory costs should be rationalised.

Reduction in regulatory costs will help small commodity traders who are out of the market.